Dean Baker: 'This isn’t going to be TARP II'

I was talking to the Center for Economic and Policy Research's Dean Baker about the foreclosure mess earlier today, and he was notably less concerned than some of the other voices I've featured on the blog. "The idea that it’ll bring wholesale collapse is far-fetched," he told me. "Some banks will be liable for lawsuits, and you could even see some people going to jail. They were signing documents saying they reviewed the paperwork when they clearly didn’t, and that can be criminal. But the idea that this would threaten the big banks? I have trouble seeing it."

Among the points he made was that if the underlying "note" on a home isn't valid, it doesn't mean the borrowers are free and clear. They still owe the bank for the amount of the loan. The bank just can't foreclose on them. In most cases, the homeowners will just continue to pay as much of their mortgage as they can. "The people still owe the money," Baker says. And over time, "it’ll be a pain for the banks to get the paperwork in order, but I imagine in 90 percent of the cases they’ll be able to do it."

As for whether lawsuits will force a trillion or so dollars of mortgages back onto bank balance sheets, Baker didn't buy it. "There might be some bank up to its neck in garbage," he says, "but it won’t be Bank of America. It'll be a small bank. This isn’t going to be TARP II."

Which isn't to say it won't register at all. Bank stocks are falling today, and credit derivative spreads are widening.

I'm fraid Dean doesn't know what he's talking about. Your payment is only valid legally if you are paying the owner of the note. Ask the entity you are paying to show you the note.

Second biggie: disgruntled REMIC investors are arguing that the "homeowner" is a co-conspirator with the lender. The "homeowner" is therefore a trustee of a constructive trust which contains the title. Therefore, the judge can order the trustee to convey title to the beneficial owner: the REMIC.

REMIC investors who are not getting their income stream are not going to go after a gazillion homeowners: they are going to go after the REMIC claiming that the REMIC holds title and that the supposed "homeowners" only hold that title in trust.

Guess what? They will win.

Guess also what? This argument also applies to those who owe NOTHING on their mortgages.

I would imagine that defects in the assignment of notes and liens can be remedied in most cases. And, failing that, I would imagine that homeowners who wish to contest foreclosure in court will have to either cure their default or prove that they are not in default at all. So yes, Baker is correct, I think, in the long run. But in the short and intermediate term, banks have got an enormous and expensive headache on their hand. Even more enormous and expensive than it already was, which is the reason these foreclosure mills and shoddy practices arose in the first case.

Doesn't the real threat of wholesale collapse come from the ability of pension funds and institutional investors now having justification to sue for any losses they incurred from securities/derivatives that were composed of fraudulently represented and documented mortgages?

I agree with Baker that the actual mortgages/foreclosures are a huge headache that will ultimately be solved in 90% of the cases, but the real problem is the fraudulent investments that were leveraged on top of this mess, no?

Dean Baker's remarks sound much like the comments of those who claimed that there might be some minor players who were in trouble with subprime loans, but surely the big boys knew what they were doing. Until we see just how pervasive the problem is and whether it CAN be fixed, it's much more realistic to assume there's an enormous problem because if the past three years has taught us anything, it's that the people in the financial industry who allegedly know what they're doing really have no clue.

So, while Baker is likely correct that the foreclosure mess will likely work itself out in time, this:

"There might be some bank up to its neck in garbage," he says, "but it won’t be Bank of America. It'll be a small bank. This isn’t going to be TARP II."

overlooks that it's not the banks necessarily that are up to their necks in garbage. It's Fannie, Freddie and the Fed. And pension funds, 401Ks, and insurance companies.

And he shouldn't discount the likelihood that a lot of drek will be pushed back onto bank balance sheets. If not because of defects in foreclosure, then because of defects and fraud in origination.

And the big, giant elephant in the room that he managed to overlook is that most of this stuff has yet to be marked to market on the books of the entities who hold it. Thus far extend and pretend has been successful, but the furor over the foreclosure mess may be the thing that blows it all sky high.

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